Hicks, J. Rush Jr. (2000). Should a Record Company Be
Alarmed When an Artist Files for Bankruptcy? MEIEA Journal Vol 1 No 1 ,
84-117.

Should a Record Company Be
Alarmed When an Artist Files for Bankruptcy?

by

J. Rush
Hicks, Jr.

Middle
Tennessee State University

The
bankruptcy laws were enacted to allow a person a “fresh start” in life
by relieving a person of debts which were difficult, if not impossible,
to repay. There are certainly pros and cons to the current U.S.
Bankruptcy Act and members of Congress have proposed legislation to
tighten-up on some of its perceived loopholes. Because of the
substantial sums of money an artist can make in a relatively short
period of time and the natural desire to live a lifestyle of a
celebrity, many artists have found it necessary to ask for bankruptcy
relief early in their career. Artists begin questioning why their
success at record stores does not translate into substantial royalty
payments by the record company and many attorneys and business managers
inform their clients about the relatively small royalty payments they
receive in proportion to the windfall received by the record company.

Historically,
record royalty rates in contracts have been based on the suggested
retail price of records but numerous items such as reserves against
returns, free goods, foreign royalties, packaging deductions and the
recoupment of the costs of the albums and videos are deducted from the
artist’s royalty rate. The resulting royalty payment to the artist, who
possibly has achieved multi-platinum sales, is usually pennies compared
to the profits of the record company. On the other hand, the record
company would argue the costs of “breaking” an artist to the public is
enormous and the failure rate of most new artists is very high.

Take
the scenario of an artist who has struggled for years to break into the
music business and finally secures that all-important major label
recording contract. The artist knows that success at the record store
can translate into opportunities for exposure on television, increased
tour dates, merchandise sales, and finally, a six-figure royalty check
from the record company. The artist incurs debt almost immediately and
does so without a thorough understanding of the deductions the record
company will make before payment reaches the artist. The artist
commences lavish spending to keep up with other artists because, after
all, everyone knows an artist with a hit record will acquire
substantial wealth. A year goes by and the artist’s business manager
relays the grim news to the artist. You are unable to pay your debts,
e.g.,, you are insolvent. The artist, after denying reality, consults
an attorney. The attorney examines the artist’s financial condition and
recommends filing for bankruptcy. Depending on the particular situation
of the artist, the bankruptcy case can be filed as a chapter 7, 11, or
13 and the artist (now referred to as the debtor) will be granted
relief from most debts and unsecured creditors (as opposed to secured
creditors holding collateral) will generally receive a few pennies on
the dollar. A Chapter 7 bankruptcy, called a liquidation, will
discharge the debtor from all existing debts while a Chapter 11
bankruptcy called a business reorganization and a Chapter 13
wage-earner bankruptcy petition allows the debtor to repay their debts
over time.

Section
365 of the U.S. Bankruptcy Act, however, also provides for relief from
executory contracts considered burdensome to the debtor’s estate.
Executory contracts are agreements that have obligations remaining to
be performed. Artists and their attorneys began looking at the
executory contracts provision of the U.S. Bankruptcy Act with the
purpose of terminating what the attorney considers a one sided
agreement; possibly re-negotiating a new agreement with a different
record company who recognizes the value of having this particular
artist on their roster; or, as a ploy to re-negotiate the existing
deal. Interestingly, some recording artists in the U.K. have been
successful in challenging one-sided or unconscionable recording
contracts but U.S. civil courts have continued to enforce such
agreements. U.S. courts have found that recording artists generally
seek legal counsel to negotiate their recording agreements and then
enter into these agreements voluntarily and not under duress. Thus, the
artist looks to the bankruptcy court for relief and as long as the
intent of the artist in requesting bankruptcy protection is to be
discharged from debts the artist is unable to pay, a bankruptcy court
will not block the debtor’s efforts to be relieved of an executory
contract. Compared to litigating the terms of a contract in civil
court, which generally is time-consuming, decisions in Bankruptcy Court
are typically swift. More importantly, the artist/debtor maintains some
leverage over the record company, unlike the realities of the
marketplace where artists accept one-sided agreements in the hope of
landing a record deal.

A
typical recording contract, considered a personal services agreement,
provides for the artist to record a minimum number of albums with the
record company cross-col-lateralizing the unrecouped recording costs
from prior albums with royalties generated from possibly future
successful albums. Some record companies also cross-collateralize
unrecouped recording costs against royalties earned by the
artist/songwriter from the record company’s affiliated publishing
company. For years, artists have complained about the relatively small
amount of royalties generated by recording artists compared to the sale
of their records. Unless an artist reaches superstar status, the record
company’s recoupment of production and recording costs make it
virtually impossible to earn significant royalties. Record companies
have over the years established provisions in record contracts that
make it very difficult for the artist to reap the rewards of their
sales success. Returns against reserves, packaging deductions, the
producer royalty, controlled composition clauses (reduces mechanical
royalty income to the artist/songwriter by 25%) and “free” goods are
some of the items that have reduced an artist’s anticipated royalty.
Combined with recoupment of recording costs, video production costs,
tour support, and independent record promotion, the artist will receive
only a small portion of the revenue from gross album sales. New
artists, unaware of this disparity, dream of the day when they will be
offered a recording contract with a major record label. The
relationship usually begins to deteriorate shortly after the artist
receives the first accounting statement reflecting a substantial
unrecouped balance. Even after achieving sales certifying a “gold”
record, the artist will barely recoup expenses and must, therefore,
depend on other sources of income such as publishing and touring.
Record companies believe it is in their best interest to contract with
an artist for as many as eight albums to offset the enormous costs of
“breaking” an artist in the marketplace. The artist does not have a
contractual right to prevent the record company from calling for
additional albums or to drop the artist from its roster based on lack
of album sales, but it is common for successful artists to attempt to
renegotiate the terms of their contract.

Once
the artist files for bankruptcy, a court-appointed trustee administers
the estate and has the authority under Section 365 to cancel executory
contracts. The courts have struggled with defining executory contracts
since the Bankruptcy Act does not do so. Black’s Law Dictionary defines
an executory contract as a “contract that has not as yet been fully
completed or performed. A contract the obligation (performance) of
which relates to the future.” The debtor who entered into a recording
contract which has obligations
remaining, such as delivering future albums, gives the trustee the
authority to reject the contract. This allows the artist to possibly
re-negotiate the terms of the existing record contract or enter into a
new agreement with another record company with larger advances and
higher royalty rates. Unfortunately, the record company’s remedy is to
be considered an unsecured claim against the debtor with the record
company sharing proportionately in whatever monies the debtor’s estate
has generated.

If
the record company, however, can establish to the satisfaction of the
bankruptcy court that the debtor filed the petition with the sole
purpose of rejecting an executory contract for the purpose of then
entering into a contract with another record company, the Court can
dismiss the case. A Chapter 11 bankruptcy petition was filed by an
actress on the TV series “General Hospital” who attempted to reject her
contract with the network. The Court determined, after reviewing her
admission as to why she filed for bankruptcy protection, that her
petition was filed in bad faith and subsequently dismissed the case. In
Re Carrerre, 64 B.R. 156 (1986). In the case of Delightful Music Ltd.
v. Taylor, 913 F.2d 102 (1990), James Taylor, lead singer for the
musical recording group “Kool and the Gang,” filed a Chapter 11
bankruptcy petition and promptly moved to reject a recording contract
with Polygram Records and Delightful Music. The trial court found that
James Taylor had guaranteed certain promissory notes for the members of
the group and incurred his own debts totaling in excess of $1,000,000.
Additionally, he and the group had an unrecouped balance with Polygram
Records of $950,000 and internal loans to their company of $2,000,000.
James Taylor listed assets of less than $750,000, the bulk of which
constituted his personal residence. Polygram Records and Delightful
Music attacked the majority of the debts because they believed
guarantees should not be considered debts for filing a petition
amounting to bad faith. The Bankruptcy Judge examined the language in
the promissory notes and agreed that state law made these guarantees
enforceable against the debtor and that future sales of “Kool and the
Gang” recordings were speculative and probably not sufficient to recoup
the advances. Polygram asserted that the debtor’s purpose in rejecting
the recording contract was to allow him to enter into a new recording
contract thus concentrating his efforts in generating future income to
the detriment of the existing creditors, namely Polygram Records and
Delightful Music.

The
grunge band “Gruntruck” found themselves in 1993 with an unrecouped
balance owing to their record company, Roadrunner Records, totaling
$130,000. All Blacks B.V. v. Gruntruck, 199 Bankr. 970 (1996). Because
of decreasing record sales, increasing recording costs and tour
expenses, all of the members of the group filed Chapter 7 bankruptcy
petitions to be discharged from their indebtedness to Roadrunner
Records and to terminate their record contract. The U.S. District Court
Judge distinguished In Re Carrere because it did not appear to her the
members of Gruntruck had been offered another record contract nor filed
in bad faith solely to terminate their existing record contract. A
similar result occurred in the case, In Re Ferrell v. Robinson Mann
Creative Enterprises, Inc., 211, B. R. 183 (1997). Ricardo Brown p/k/a
“Kurupt” sought to reject a record contract with his record company,
Death Row Records and at the time he filed his bankruptcy petition,
Ricardo Brown had assets of slightly more than one million dollars and
debts exceeding twenty million. Despite recording with many of the most
popular rap artists, Mr. Brown earned less than $200,000 from the
record company and had an unrecouped balance in excess of One Million
Dollars. The Bankruptcy Court permitted him to terminate his record
contract because he was unable to earn any money since he had
previously rejected the record contract and was no longer performing
under the terms
of the agreement. The Court, however, did not rule as to whether he
would be entitled to enter into a new agreement with a third party
record company which would clearly be in breach of the underlying
contractual obligations with Death Row Records. This ruling is limited
in scope to the laws of California which generally favor artists over a
record company employer.

A
recent case underscores the substantial impact a bankruptcy petition
can have on the artist and record company. In Re Watkins, Lopes and
Thomas, 210 B.R. 394 (1997). The musical recording group, TLC, consists
of three female artists who signed with an Atlanta-based record
company, LaFace Records. The group achieved multi-platinum sales after
some half-dozen radio singles, but found themselves in financial
distress and filed bankruptcy asking the court to terminate their
record contract. TLC’s contract provided for a relatively low royalty
rate of seven percent escalating to nine percent by the eighth album,
considerably less than most major recording contracts. LaFace Records
argued that because other labels dominate the record distribution
channels, independent labels like LaFace are forced to offer lower
royalty rates. Most record companies had developed a pattern of
re-negotiating recording contracts when the artist achieved significant
record sales, but LaFace Records refused to meet the demands of TLC,
thus prompting the filing of the bankruptcy petition. LaFace Records
argued against terminating the record contract because it claimed there
were sufficient royalties in the pipeline to pay the debts of TLC, but
that the members of TLC refused to accept advances against those
pipeline royalties. The Bankruptcy Court refused to dismiss the case
and found the filing to be proper rejecting the argument put forth by
LaFace that the bankruptcy filing constituted “bad faith” because TLC
wanted to void their record contract. Before, however, the Judge ruled
on the request to terminate the record contract, TLC and LaFace reached
an agreement which in essence provided for all of the group’s debts to
be paid, a significant payment made to the artist and an increase in
the royalty terms of their record contract. Shortly after this
settlement, LaFace again faced the prospect of an artist being relieved
from the obligations of a recording contract. Toni Braxton, whose
records reportedly generated more than $170 million in sales, filed a
bankruptcy petition claiming she made only 35¢ per album while
LaFace
and others profited substantially from her creative efforts. She
attempted to have her LaFace Records contract discharged according to
Section 365 after reportedly refusing an offer of 10 million dollars
from her record company. Recently, she and LaFace Records were able to
resolve their contractual differences and she entered into a new
recording agreement with LaFace which recognizes her value in the
marketplace.

Last
year, Congress began debate on amending the current bankruptcy law and
record companies were quick to encourage the drafters of the Bill to
correct the perceived unfairness of Section 365 in regard to recording
contracts. The principal debate of the amended Act focuses on “means
testing” of filers with the goal of keeping high-income debtors out of
Chapter 7 bankruptcy and placing them into Chapter 13 to repay more of
their debts. Currently, a debtor can proceed with Chapter 7 bankruptcy
unless a court finds “substantial abuse” of the process. The amended
Act would replace the substantial abuse standard with a means test
focusing on the ability of the debtor to repay debts under Chapter 13.
Early drafts of the legislation also contained exemptions for
agreements between artists and record companies from the
dischargability of executory contracts, but organizations protecting
the rights of recording artists became alarmed and language was
inserted to alleviate most of those concerns. In the House of
Representatives version of the Bill, H.R. 3150, the Recording Industry
Association of America
(RIAA) was allowed to add a new section 212 to the Bankruptcy
legislation that prevented a recording artist from using the bankruptcy
laws to terminate a recording contract. Two major artist unions, AFM
and AFTRA, criticized the new provision and noted that only recording
artists had been singled out for separate treatment in this Bill and
that current bankruptcy law allows a court to dismiss a bankruptcy
petition filed in bad faith, thus potentially providing relief to a
record company. Debate on the floor of the House was led by
Representative Scott from Virginia who opposed the insertion of the
language protecting record companies. He felt that the legislation
singled out recording artists for detrimental treatment and cited a
statistic from Billboard Magazine that one percent of all American
adults filed for bankruptcy in 1997, but less than one-tenth of one
percent of recording artists filed. He further stated that “Section 212
provides a new legal standard which will penalize recording artists for
using provisions of the bankruptcy code available without such penalty
to all other debtors similarly situated.” He continued saying “Section
212 does not apply to actors, does not apply to athletes, doctors,
lawyers, professors, authors or anyone else who signed a personal
service contract.” Rep. Tauscher from California, who supported the
measure, pointed out that “this provision would not deny anyone access
to bankruptcy. It would not deny debtors in genuine economic stress the
ability to rehabilitate their finances. And it would not deny or not
give recording companies a preferred creditor position.” She
characterized her support as good national policy and protection of a
home-state economic interest. Cary Sherman, senior VP and General
Counsel for the RIAA complained that some recording artists who receive
substantial advances from the record company and run up huge debts,
then file bankruptcy to walk away from their obligations just when the
record company is about to reap the rewards from the artist’s success.
Sherman further stated that bankruptcy can be used as a “threat that
enables artists to extract money from record companies by threatening
something worse.” On June 11, 1998, the United States House of
Representatives overwhelmingly passed the draft of the Bankruptcy
Reform Bill containing the provision sought by the record companies.
The applicable language provided that the rejection by the trustee of a
record contract “shall not in any way diminish or impair any applicable
nonbankruptcy law rights to enforce noncompetition provisions regarding
the rendering of exclusive services as a performing artist that may be
contained in such contract.” The RIAA then issued a statement saying
the change in the law was necessary to close the loophole being
exploited by “increasing numbers of agents and lawyers for popular
recording artists who have been misusing the bankruptcy process to get
out of long-term contracts in order to sign alternative, more lucrative
contracts.”

The
U.S. Senate’s version, however, did not contain the recording contract
provision and so the RIAA agreed to support a compromise to the House
provision. The Trustee will be prevented from terminating a recording
contract which provides for future master recordings “if a material
purpose for commencing a case is to reject such contract…” unless a
bankruptcy court finds it necessary to reject a record contract for the
economic rehabilitation of the debtor. The Court will then be required
to examine the totality of the circumstances in determining whether the
debtor who seeks to reject a personal services contract does so because
of the financial need for such rejection. The RIAA and AFTRA released a
joint statement agreeing the issue had been resolved which would
specifically address the “bad faith” provisions of the reform bill
without creating a special rule for recording artists. The Bankruptcy
Reform legislation is still pending in Congress, but the effect of the
new rule will undoubtedly affect the future relationship between
recording artists and their record companies. This Congressional debate
will strongly encourage each of the parties and their attorneys to
craft language in future recording contracts that recognizes the need
to adequately compensate new and successful recording artists while at
the same time compensating the record company for the substantial
investment needed to “break” that next superstar act.

References

Brooklyn
Law Review 409 (Summer, 1997). “Can Superstars Really Sing The Blues?
An Argument for the Adoption of an Undue Hardship Standard When
Considering Rejection of Executory Personal Services Contracts in
Bankruptcy.” by Alison J. Winick.

“RIAA Wins One on Bankruptcy,” by Brooks Boliek, June 11,
1998, issue of The Hollywood Reporter.

“Putting Back the Bite,” by Michael Higgins, June, 1998,
issue of the ABA Journal.

“The Rap On Personal Services Contracts,” by Michael A.
Bloom and Ashely M. Chan, May, 1998, issue of The New York Law
Publishing Company.

Biography

Dr.
Rush Hicks, assistant professor of recording industry, received his
Bachelor of Music degree from the University of Mississippi. He earned
his law degree from Mercer University in Macon, Georgia, and also
completed music business courses at Belmont University in Nashville.
Hicks worked as an associate for the firm of Johnston & Brannen in
Statesboro, Georgia, before moving his entertainment law practice to
Nashville to join in a partnership with David Maddox. Currently, Hicks
maintains a private practice in Nashville. His clients have included
Randy Travis, Restless Heart, John Anderson, Aaron Tippin, Take 6 and
Glen Campbell Enterprises. Hicks is a member of the Tennessee and
Georgia bar associations. His memberships also include the Country
Music Association, the Gospel Music Association, Nashville Songwriters
Association and the National Academy of Recording Arts & Sciences.